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Wednesday, January 23, 2008

How does the National Bureau of Economic Research (NBER), the officialarbiter of U.S. business cycles, determine the beginning and end of arecession? A peak in the business cycle marks the end of an expansion andthe beginning of a recession. The traditional role of the committee is tomaintain a monthly chronology so they refer almost exclusively to monthlyindicators. As a result of this monthly focus, the committee gives relativelylittle weight to real GDP, which is only measured quarterly and subject tocontinuing, large revisions. The broadest monthly macroeconomicindicator is employment. The committee also generally studies anothermonthly indicator of economy-wide activity, real personal income lesstransfer payments (top graph) adjusted for price changes. In addition, thecommittee refers to two indicators with coverage of manufacturing and thebroader sales and distribution of goods: (1) industrial production (middlegraph) and (2) the volume of sales of the manufacturing and trade sectors(bottom graph).Following the NBER methodology, we created ‘spider charts’ for all fourindicators as if September 2007 was the business cycle peak. Real personalincome less transfer payments, peaked in September 2007 and then fellslightly over the next two months. Industrial production also confirmsSeptember 2007 as the peak. The real manufacturing, trade and sales dataare still trending upward as of November, but the advance report on retailsales for December indicated a decline in at least one component ofbusiness sales.On the positive side, our fourth indicator, employment continues toincrease. This is the one factor that appears to be keeping the economyfrom falling into a clear recession since employment is holding uphousehold income and, therefore consumption.The September Break: Data Suggest Downturn Could Have Begun ThenUp until September our key indicators did not suggest a recession, butsince then these same indicators show a clear shift in the economic windsand therefore a bias toward caution for decision-makers. We can never beabsolutely sure about recessions but we can learn with the data. Theysuggest that a recession is an even bet unless public policy, as it did in1987, reacts swiftly and effectively to avert the downturn. To corroboratethis cautious outlook on the economy our empirical model of recessionsuggests a 59 percent chance of recession as of the November data.Real Manufacturing and Trade SalesIndex, September 2007 = 10.960.970.980.991.001.01Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-080.96